Wednesday, April 17, 2013

Light Dawns on Marble Head

A friend of ours was fond of using
the expression, "light dawns on marble head" as he slowly perceived what he
believed to be obvious and right there before him had he only been more attentive. So it may be with all
of us, from time to time. Sometimes things are not at all obvious, though, and
we're simply being modest, as was the case with our friend. Sometimes it's
simply a matter of jotting things down that can be viewed in plain sight.

Plotted below is the yield on the 30-year UST at roughly its high and low marks for the year, for each of the past four
years (2010-2013). The cyclical high yield in each year has come in the rather narrow period of late
March – early April. In fact, the high yield has printed in a period
spanning no more than 26 days! US Treasury bonds, particularly at the
long end of the yield curve show their greatest price reaction to economic
strength or weakness, signs that their greatest foe, inflation, might be
creeping in or receding. Hence, when the economy appears to be at its
strongest, the 30-year trades its weakest and prints its high yield for the
cycle.

The cyclical low in yield for the 30-year
has occurred in a somewhat wider range over the past three years, from late
July – early Sept (too early to tell for 2013). While this is a wider
period than its high yield mark, this data still indicates a span of less than 45
days. Now, perhaps this is purely
coincidental that the 30-year would signal its greatest price strength and weakness at
precisely the same time each of the past four years. Or perhaps, there's
some pattern worth discerning.

Why this pattern might occur
requires some speculation, but as another friend of ours was fond of saying,
"numbers don't lie". We believe the reason for this trend is
the economic false-starts we’ve seen for Q1 for the each of the past three
years and, we suspect, carrying over into Q1 2013. As discussed in
a previous post on this blog, the data from BLS and Commerce have been
favorable in each winter period for the past four years, causing bond prices to
weaken, only to fall off in spring and summer (causing bond prices to
rally).

We believe that this pattern is not
coincidental, but rather relates to the seasonal adjustment models that the two
departments use to account for what they believe to be normal seasonal
patterns. If true, these factors are distorting the picture of growth in the
winter months, causing the UST long bond to weaken substantially (in price)
only to recover strongly as that growth fails to carry forward into the warmer
months.